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For several years and for equally several reasons, there has been an increasing tension between the United States of America (USA) and China. One major thorn in the flesh is the implementation of tariffs which seems to have spawned a virtual trade war between the two. The ongoing trade war between these two powerful nations may have repercussions and definite implications which will affect the global and the Indian economies.

“The standard graduate economics textbook extolls the virtues of free trade as it maximizes the gains to the consumer and prevents any wastage of resources caused by idle capacity or unmet demand,” informed Madhuri Saripalle, Associate Professor of Economics, Institute for Financial Management and Research Graduate Business School, Krea University, Sricity, Andhra Pradesh.

Madhuri Saripalle on the impact of this ongoing trade war on the world economy and on the Indian economy:

In the real world, however, one does not find such an ideal model where goods and services move seamlessly across borders, exchanging at prices that are close to the marginal cost of production. Although free trade may seem to benefit consumers by way of competitive prices, it does not consider the impact on the distribution of income. For instance, in a developing economy with skewed income distribution, resources may get diverted from a labour intensive to a more capital-intensive process of production or, from small to big producers. Therefore, one needs to view the trade barriers in the broader context of the political economy of the country. In reality, markets are always fragmented with boundaries drawn by tariff and non-tariff barriers as each country tries to protect its powerful business lobbies or political interests. Having said that, one needs to carefully assess if the trade barriers are a temporary macro-economic policy measure and the extent to which they may impact related goods and services in the context of global financial and production networks. Finally, are these measures going to have a ripple effect on macroeconomic parameters and has the potential to create an economic crisis? It is in this context that the recent trade war triggered by U.S and China needs to be deliberated upon.

To begin with, the tariff imposed by the United States on steel and aluminum will increase the cost of production of user industries such as automobile producers, who in order to cut costs of production, will put pressure on the suppliers for cost reductions. A similar story is being played out in India as well with the anti-dumping duties imposed by India on Chinese steel. While this has benefited the steel majors, it does not shift or increase demand for domestic steel because purchase decisions are bound by contracts and do not change overnight; also, some components need to be imported for quality control. Further, foreign subsidiaries have implicit agreements with preferred input suppliers and cannot cut back on imports. So, in order to be cost competitive, input suppliers and upstream industries suffer as they bear the brunt of reduced margins.

A second possible impact of trade barriers is the impact on general price level and an increase in inflation. Take soy oil for instance. The tariff imposed by China on US soy bean, had a ripple effect on India, the world’s largest consumer of vegetable oil. In April, the government of India hiked import duty on edible oil and also increased minimum support prices on soybean production to encourage domestic production of soybean and soy oil, thereby increasing domestic oil prices. The tariff imposed by China on U.S. soy bean added further fuel to the rising oil prices in India by increasing the demand for soya bean. A silver lining for India is the potential for soybean exports. However, India has to clear other non-tariff hurdles like quality control measures and scaling up production in the organised sector which are long term measures. In the short term, the price rise may contribute to inflationary pressures. In sum, in an era of inter-connected financial markets and inter-woven supply chains, trade wars will hurt the entire value chain of an industry, impacting the downstream and upstream actors spread across the globe. Some of the impact may be to India’s advantage given that it has the potential to scale up and break into export markets swiftly.

Bangalore-based Arun Balakrishnan who is the former Chairman of HPCL and an independent director in several companies feels that the major manifestation of trade war in the world is between the top two economies namely USA and China. He informed, “The latter uses every trick in the trade to better the number one. The number one retaliates in whatever way it can, never mind the collateral damage.”

He added, “India has not been impacted to any great extent as it has smartly raised the protectionist wall without attracting too much attention from the multilateral agencies. The greater impact would come from the USA action restricting H1B visas and trade embargoes of its sworn enemies - Iran and Russia. Some astute diplomacy has worked here, and exemptions have come to our rescue. Oil is what could have laid India low. But shale oil came to our rescue. Mostly because shale oil output is decided by multiple shareholders of multiple companies in USA unlike the dictators in Saudi Arabia and its friends such as Russia. So we continue to sail along.”

Even though India is lagging behind the major oil producers when it comes to conventional oil reserves, it has a huge potential in shale oil. A few years ago, the ONGC, India's largest exploration group (according to revenues), hailed the shale gas discovery as Asia's first. How all of these will impact the Indian economy, is an ongoing spectacle that constantly worries our economists and administrators. The silver lining is that, we as a country is known to be resilient and has always not just bounced back but traversed around impediments to show a winning side.